The "What Comes Next" title is a reference to one of the songs sung by King George in Hamilton. We can't quite put our finger on it, but it feels like there are certain parallels between Mad King George and our current situation.
What exactly is our current situation? From an S&P 500 standpoint, we're back to where we were at the start of September. These 11 weeks have been far from flat, though. Down 10% over the first three weeks in September, then up 10% over three weeks into October, then down almost 8% in the three weeks leading up to the election, and then up 10% in what can only be described technically as a face-melting rally since the election.
To recap: pre-election, there were widespread expectations of a "blue wave", and the market sold off a bit because it didn't like seeing the specter of inflation in all the anticipated government spending that presumably Democratic Executive and Legislative branches would entail. As election results came in and the blue wave never materialized, the market rallied. A Deomcrat presidency with a Republican Senate probably means gridlock in DC and not much in the way of fiscal stimulus. Thus, the burden of economic stimulus continues to fall to monetary policy and the ever-ready dovish accommodation of the Fed. Moar QE, in short. And as we have detailed previously and somewhat exhaustively, QE is good for stock prices.
Then Monday morning last week, Pfizer came out with a positive announcement on their vaccine's Phase 3 trial, and the market rips. Small caps up 8%. Airlines up 16%. Cruise lines up 23%. Movie Theaters up 60%. Retail up 24%. Even Hertz (still in bankruptcy, by the way) up 25%. Face melting.
As we write this, the market is in the middle of a face-melting rally. And yes, that's the technical term for it. To recap: in the three weeks before the election, the market lost 7.5%. There were widespread expectations of a "blue wave", and the market didn't like seeing the specter of inflation in all the anticipated government spending given Democratic Executive and Legislative branches.
Since election day, the market's up 11%. In a week. Initially, the market rallied on the much ballyhooed "blue wave" not materializing. If there's continued gridlock in DC, then it falls to the Federal Reserve to try and stimulate the economy. Which means more QE. Since all QE really does is drive up stock prices, the market was happy.
And then this morning, Pfizer comes out with a positive announcement on their Phase 3 trial, and the market rips. Small caps up 8%. Airlines up 16%. Cruise lines up 23%. Movie Theaters up 60%. Retail up 24%. Even Hertz (still bankrupt, by the way) up 25%. Face melting.
The problem here is that nobody really knows anything.
Well. The scariest night of the year is almost upon us (take your pick of October 31st or November 3rd), and it definitely feels more trick than treat in the markets this week, doesn't it? Monday was off a couple percent, no bounce on Tuesday, and then down another 3.5% Wednesday. A little bounce yesterday, but all given back again so far today. Frustratingly, Wednesday's selloff was another one of those days where literally everything sold off. Stocks, bonds, gold..everything. To put that into perspective: stocks, bonds, and gold all down on the same day has happened twice. Ever. And both those times were back in March of this year.
Which kind of makes sense...the catalyst for the selloff is a little murky, though it seems like Europe (at least Italy, Spain, France, Germany, UK, Belgium, Czech Republic, and Poland) reinstating various lockdown measures is largely to blame. Domestically, optimism around a fresh stimulus deal seems misplaced (though does that actually surprise anyone a week before the election?), and the election races seem to be tightening.
A few weeks ago, the default positioning on elections felt like expectations of a "Blue Wave" result next week, and markets had been rising ahead of an expected proverbial opening of the government spending floodgates. Now, it feels like there is a reconsideration of that outcome. Markets hate uncertainty. The worst possible outcome (for markets) is a contested election that has to spend months working its way through the courts. Tighter polls make that outcome marginally more likely, so perhaps what we're seeing in this selloff a broad deleveraging of risk assets. Or maybe it's the opposite of what we saw back in Q2 and is a bit of a negative gamma squeeze.
In the spirit of Halloween, we'll take this newsletter in less of the obvious Bruce Banner/Incredible Hulk direction and more of a The Gamma People/Creature with the Atom Brain direction as we dive into what exactly gamma is and how it moves markets.
How much money do you need to be wealthy? According to a poll conducted by Schwab last year, it's about $2.3 million. Unsurprisingly, that number varies depending on the age of the respondent. Gen Z-ers think $1.5 million is wealthy. Millennials think it's $2M, and Gen X and Boomers think it's up over $2.5 million. Interesting that all those numbers are pretty solid anchor points: one-and-a-half, two, two-and-a-half...psychologically speaking, it feels like the survey respondents just picked a random number out of thin air. The pre-k demographic wasn't surveyed, but one can assume their response would be along the lines of "one thousand thousand million hundred thousand and nine". Our answer: it depends.
We're going to open this note with a slight adaptation to the musical stylings of Salt-N-Pepa:
Let's talk about symmetry
Let's talk about you and me
Let's talk about all the made up
Things the Fed has caused to be
We are, of course, referring to the Fed's recent "policy decision" from Jackson Hole. (According to Strunk and White's classic Elements of Style (updated and annotated by Robertson), when referring to the Fed, "policy decision" should always be in quotes, to denote its made-up nature).
The "policy decision" essentially codified a symmetrical inflation goal. To translate with some background for anyone not fluent in Fed-speak:
One of the explicit reasons for being of the Fed is to "maintain price stability" (direct quote quotes, not made-up quotes this time). They used to take that literally and target actual price stability. Then in 2012, there was a new "policy decision" (back to make-believe) that said price stability meant 2% increases in price every year. That doesn't sound particularly stable to us, but the Fed hath spoken and so shall it be.
Does Halloween lose a bit of magic because people have been wearing masks for 6 months already? Resoundingly, no. Sure, it may be more trick than treat this year, but Halloween itself is about the atmosphere - shorter days, cooler evenings, foggy mornings, zombies...yes, the zombies. We are in the middle of a zombie apocalypse - you see them every day and probably have no idea until they collapse and die right in front of you. One of the more recent ones to be decapitated and burned (take your pick of favored zombie disposal methods) is...Hertz.
That’s right, we’re talking about zombie companies! Zombie companies are those that should have gone out of business a long time ago, but have been reanimated through the Fed’s zero interest rate policies. Without going on another rant about how the Fed has destroyed the notion of productive capital allocation, here’s how zombie companies form:
The upshot of last month's webinar, for those of you that missed it, was that the Fed is turning the stock market into a house of cards, but you might as well make yourself comfortable in it. Recently, we've been having a number of conversations that suggest we need to elucidate that point a little further than can be accomplished in a 40-minute Zoom. So here we go:
What is investing?
Are you "investing in companies" when you buy into the stock market?
99% of the time you are not investing in a company. The only ways you can actually invest in a company are: public stock offerings (usually IPOs); public debt offerings; private equity or debt deals. Last year, there were a low-200's number of IPOs that raised around $62B total. Through the first half of 2020, there have been 64 IPOs that raised $22.3B. The total value of the US stock market is right around $30T with a "T". So in any given year, about 0.2% of the stock market is actual "I want to invest in your company" money.
You've seen a record $1.2T in new bond issuance (more on this in a bit) year-to-date in a $40T bond market. Private markets are up to about $6.5T total and have added $370B or so a year (including performance). So recently, in any given year, you could reasonably expect about $1.6T in real "give this company my money" investment. In a combined stock/bond/private marketplace in the US of $77T or so. That's 2%.
Okay, sorry, we were wrong: 98% of the time you are not investing in a company (though really, most of that 2% is limited to a very select few, so in our defense it is likely closer to 99%).
So what are you investing in? When you buy your shares of Apple or Tesla or Aurora Cannabis, you aren't giving your money to the company for them to do amazing world-changing things with. You're not giving your money to the company at all. That's why the stock market is a "secondary" market - you're giving it to the person you bought the shares from.
This month we're going to talk about a somewhat taboo subject in investing: gold. There are those who still hold that gold is nothing more than a "barbarous relic", a literal lump of rock that, while shiny, produces nothing, yields nothing, pays nothing, and is essentially a way that financial companies have found to charge you for keeping money under your mattress.
On the other side are those convinced that gold is a necessary store of value in a world where paper money is backed by nothing more than the (perhaps rapidly eroding) "full faith and credit" of the issuing government. Our money used to be backed by gold and silver. Now it's backed by nothing. And in point of fact, there aren't even enough paper dollars to cover the amount of money in the US economy.
Gold bugs tend to get a bit of a bad rap and are lumped in with doomsdayers and naysayers of various ilks. But with gold at all-time highs over $2,000 an ounce, let's try and take a rational look at why and how one might invest in gold.
Because we're also doing a live market update this month, this note is (hopefully) going to be on the shorter side...but no guarantees.
We've written about inflation before. It was a couple years ago now, and the thesis was basically that wage inflation would pick up, signaling minimal slack in the economy and the need for tighter monetary conditions going forward that had the potential to prick the stock bubble. Spoiler alert: that didn't so happen so much. Real wage inflation did pick up and actually spent most of 2018 and 2019 above 3% before sliding back to the mid-2%'s as the calendar turned into 2020.
What ended up popping the equity bubble was not wage inflation but rather a little spike protein on the surface of the SARS-CoV-2 virus. Of course, that equity bubble was subsequently reinflated faster than you could say "Thank you sir, may I have another", but there's still an interesting question of inflation on the table.
Namely: are we headed into disinflation/deflation, or are we headed in the other direction into (perhaps significantly) higher inflation? It's an important question, because the kind of investments that tend to do well during inflationary regimes are categorically not the kind of investments that tend to do well during deflationary regimes.
Robin Hood: Men in Tights - a great movie from the early 90's (which, not to make anyone feel old but was 30 years ago) starring Westley from The Princess Bride, Dave Chappelle, and Patrick Stewart.
Brilliant! Anyway, it's a Mel Brooks movie, so it's a hilarious parody of the Robin Hood story, in a similar vein to Young Frankenstein. And this is relevant to this month's note because there is another hilarious Robinhood parody playing out right now: Robinhood, the online brokerage platform, and the parody is the stock market, and by hilarious we mean sad.
With nothing to do except stay at home under shelter-in-place orders, people apparently turned to day trading in a big way. It seems like the combination of time, boredom, stimulus checks, and no sports to bet on have people piling into the market (see: anything from Dave "Davey Day Trader" Portnoy, founder of Barstool Sports-turned day trading stock market guru who picks stocks out of a Scrabble bag and whose first maxim of investing is: "Stocks never go down"). E*Trade, TD Ameritrade, and Charles Schwab all saw record new accounts in the first quarter of the year. All 22 trading days in March were among Schwab's 30 most active days ever.
Mel Brooks has already made one parody movie entitled Robin Hood: Men in Tights. The year was 1993, and you had Westley from The Princess Bride, Dave Chappelle, and Patrick Stewart all on screen at the same time. Brilliant.
And now, nearly thirty years later, we have a real-life Mel Brooks-ian parody playing out in the stock market. May I present - Robinhood: Men in Tights (the reprise).
"Capitalism is the worst economic system ever invented...except for all the other ones."
- Winston Churchill (paraphrased) et al.
One of the main effects of this virus - and our response to it - has been to shine a light directly on all the broken parts of our societal system. A really harsh, fluorescent light. In some cases even a seizure-inducing strobe light. Whether your particular flavor of failure du jour is institutional, political, economic, macro, or micro, there is something there for everyone.
Remember all the outrage over "faithless electors" a few years ago? That was people waking up to the fact that their vote doesn't matter. In point of fact, you don't actually vote for President at all. You are really voting for which party you want to appoint a donor fundraiser elector to vote for you. This is like that, but with everything. In the interest of page limits, we'll stick to our broken economic system for now: Covid killed capitalism.
Well. We knew we didn't have any kind of monopoly on rogue waves, but this one...wow. Iceberg ahead, captain.
In early March, when stocks were down 15%, we wrote that if you were asking yourself "should I be selling stocks", our answer was "yes". Apparently, nobody listened.
Shelter-in-place orders turned people to day trading in a big way. E*Trade, TD Ameritrade, and Charles Schwab all saw record new accounts in the first quarter of the year, with Schwab alone reporting 300,000 just in March. All 22 trading days in March were among Schwab's 30 most active days ever. For the new hundreds of thousands of you that will soon be asking "should I sell my stocks", we will reiterate: yes.
What a time to be writing an April newsletter! We've picked up a few new readers since last year, so before we jump in here, just a quick reminder that April is the month we let our tinfoil hat flag fly. In previous years, we've looked at The War on Cash, the Looming Pension Crisis, and the Magical Groupthink necessary for our economic system.
In a spooky bit of foresight, last April's newsletter asked you, dear reader, to "put 1984 back on top of your summer reading list". If you didn't, do yourself a favor and definitely put it on your quarantine reading list, because we are there.
What do Machiavelli, Churchill, Rahm Emanuel, and the Washington Post all have in common? This newsletter. This month we'll look at the intersection of the phrases "Never let a good crisis go to waste" (Machiavelli/Churchill/Emanuel) and "Democracy dies in darkness" (WP). Because what we have right now in this country is a very good crisis and a whole lot of darkness. This will be a link-heavy newsletter, as we attempt to shine a light on various things that are actually happening. We leave it up to you to make your own connections and follow the rabbit hole as deep as you'd like.
Part 2. There is so much to unpack economically here, it might take us the rest of the year. So we’ll just start for the time being with a real-time post-mortem of the stock market and economy. A peri-mortem, perhaps.
Things in the land of fiat money and made up valuations are...bad. Like, Stewie destroying Mr. Rogers’s Land of Make Believe bad.
The S&P 500 had a closing high on February 19 of 3,386. As we write this on March 19, exactly one short month later, the S&P 500 is sitting at 2,323 about 15 minutes into the trading day. That is a loss of 31% in a month, which is the fastest drop into a bear market from an all-time high on record (the red line).
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